Private Credit Uncovered: Technology-enabled SME Lending
In our previous article, we went through a deep dive into Loan Origination.
The Rise of Fintech Lenders
Fintech lenders are absolutely crucial in Asia because of the large gap in SME credit. According to the International Finance Corporation (IFC), there’s a $4.1 trillion financing gap for SMEs in developing Asia. This gap is more pronounced in Southeast Asia, where SMEs contribute significantly to the region’s economy but are largely underserved by traditional financial institutions.
The emergence of technology-enabled originators (the “Fintech Lenders”) is changing this landscape. By offering digital lending platforms, they’re bridging this credit gap, providing capital for SMEs to expand their operations and contribute to the region’s economic growth.
Private credit investors can play a role in SME lending by collaborating with fintech lenders. These investors can provide additional capital to fintech lending platforms, enabling them to further support SMEs while earning attractive returns. This article helps investors to better understand how these fintech lenders function.
Deal Sourcing
Traditionally, loan originators had to manually seek out potential borrowers. For instance, this often involves prospecting directly, organising workshops, etc. Today’s Fintech originators utilise new and innovative approaches to identify and source potential borrowers. Aside from using various online marketing efforts to acquire potential borrowers directly, they also establish deal-sourcing partnerships with companies and platforms that are working with a large database of merchants, vendors, and suppliers who could become borrowers.
For instance, Funding Societies, a prominent digital financing platform, collaborates with e-commerce giants such as Lazada. These partnerships grant access to their extensive network of merchant SMEs, many needing working capital loans for operational sustainability and expansion.
In Thailand, Siam Validus, the Thai entity of Southeast Asia’s leading and award-winning SME growth financing platform Validus and SCG, a leading Thai business conglomerate with a market cap of US$11 Billion, have also partnered to enable underserved Thai SMEs to raise funds for their business via Siam Validus’ online platform.
These new and innovative deal-sourcing channels, coupled with digital technologies, enable fintech lenders to reach a broader audience, expedite the lending process, and ultimately, bridge the credit gap that traditional financial institutions have not been able to fill.
Credit Risk Analysis
One of the biggest challenges in SME lending is evaluating credit risk. Unlike larger corporations, SMEs often lack a comprehensive credit history, making it difficult for traditional banks to assess their creditworthiness.
Fintech Lenders, such as Validus and First Circle, are tackling this issue with emerging powerful technologies. These firms utilise machine learning algorithms to analyse a wide array of data points — from transaction records on e-commerce platforms to the borrower’s digital footprint — to determine credit risk. This data-driven approach provides a more holistic picture of an SME’s financial health, facilitating more accurate credit assessment.
As per the documentation of Validus from Singapore, they have enhanced their credit assessment framework through historical data and digitalisation, reducing human error. Their process includes fraud checks and credit risk assessments, considering four aspects: Industry, Company, Individual, and End Buyer.
For Industry analysis, they use quarterly reports from NUS CRI to assess default probability. Company evaluation involves corporate history (via MyInfo API) as well as short-term metrics from financial data, cash flow, and bank statement transactions. Individual assessment examines directors’ credit bureau reports, processing numerous variables. Lastly, they use Paydex data for End Buyer’s payment timeliness.
This enables them to optimise their credit risk which is reflected in their non-performing loan (“NPL”’) performance. In 2021, they announced that their default rate was under 1%. In comparison, overall NPL performance of commercial banks in Singapore is above 2% as per the Monetary Authority of Singapore.
The ability to integrate with data sources without manual labour boosts the productivity of fintech lenders, enabling them to serve customers more quickly, effectively, and efficiently. Moreover, the integration of various technologies allows for real-time updates and continuous learning, which refine the assessment models over time. As more data is collected and analysed, the algorithms become better at predicting credit risk, thus enhancing the accuracy and efficiency of the process.
Structuring Opportunities for Investors
Beyond facilitating loans for SMEs, these platforms also offer investment opportunities to individuals and institutional investors. These investments are often structured as peer-to-peer (P2P) loans, where investors can finance SME loans directly and earn interest.
For instance, platforms like Crowdo allow investors to fund a portion of an SME loan in exchange for regular interest payments. This way, even investors with smaller investment sizes can participate in SME lending, a domain once exclusive to banks and large financial institutions.
To ensure transparency, these platforms provide detailed information on each loan, including the purpose, duration, and the risk-rating derived from the platform’s credit analysis. This empowers investors to make informed decisions and diversify their investment portfolio.
Monitoring and Managing Loans
Fintech lenders persistently monitor active loans post-disbursement. Key to this process is the application of advanced algorithms that meticulously track repayment behaviours. These algorithms are designed to identify patterns that could indicate a potential risk of default early in the loan lifecycle. This allows lenders to anticipate and manage potential risks proactively.
In instances where a payment is late, these fintech platforms are equipped with systems to automatically send reminders to the borrower. This is typically the first step in a more comprehensive collections management process designed to ensure due diligence and maintain open communication with the borrower.
If a loan payment remains unpaid beyond the typical 7-day grace period, the lenders initiate a negotiation process. This process is crucial as it allows lenders to understand the unique circumstances the SME might be facing, and to explore practical methods of debt recovery. Such methods might include refinancing the loan or restructuring the existing loan terms to facilitate repayment.
If the loan remains unpaid for an extended period, typically 90 days, the loan is then considered to be in default. This status often triggers a series of more serious actions, including initiating legal recourse. Depending on the situation and the level of cooperation from the SME, this legal process might involve issuing a Letter of Demand, filing a Writ of Summons, a Statutory Demand, a Bankruptcy Petition, Enforcement Proceedings, a Writ of Seizure and Sale, and potentially Company Winding Up Proceedings.
It’s important to note that in situations where the loan is guaranteed by the directors of the SME, these personal guarantors are still obligated to repay the loan in their personal capacities. In the case of a corporate guarantee, the company providing the guarantee will be held financially responsible in the event of non-payment by the SME. These mechanisms are in place to ensure that the risk for the lenders is mitigated to the greatest extent possible.
Always Perform Due Diligence
SME Lending can offer attractive risk-adjusted returns and diversification benefits for investors seeking alternative investments. However, it’s crucial to be aware of the associated risks and challenges. Investors should conduct thorough due diligence, maintain a diversified portfolio, and stay informed about the evolving regulatory environment to navigate the world of direct lending successfully.
When you are assessing opportunities available to you on Bluejay.finance, always check out the information pack available in the data room to uncover the information mentioned above.
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Disclaimer: This is not financial or investment advice and should not be interpreted as such. Please do your own research on investments and financial decisions before partaking in any ideas or ventures depicted in this publication. Please note that historical rates of returns may not reflect future returns.
